CIMB Part I

It has been around 3 weeks working in CIMB so far, and I have much more to learn. But so far I have already learned alot. To document my what I have learnt so far in CIMB, I have dedicated this series towards writing down and sharing my experience with my readers(you) about what I have learned so far and how it is to work in CIMB.

Coming into equity research for the first time I didn't really know what to expect. The thought in my head was that research analysts are all big experts in their industry and that they must know quite in depth about their specific sectors that they cover to be able to write up reports in their industry. Meeting the people is quite different to actually knowing what they do and don’t. If only there was an easier way to tell how much they actually knew by being able to read brains. But sadly, the best way to know, I found out, was to actually work with them.

Raymond Yap. This person was my true mentor in CIMB. He is the analyst responsible for transportation covering airlines and shipping in the research house. He also got voted the best transport analyst in Malaysia by the recent Edge newspaper polls. He would be the first to give me an assignment and actually teach me about the aviation industry. I learnt that the aviation industry comprised mainly of two main businesses which were passenger and cargo. So basically, airlines can carry passengers or cargo. That is their main source of revenue. Their costs can be broken up into fuel cost and non-fuel cost. But there are many airlines in the world with different cost structures and management, so they are all run differently. However, they produce results and as the analyst we would want to compare the different airlines to see which is in the best position. Since airlines fly distances and have a specific number of seats in the airplane, a reasonable measurement is the ASK, which is available seat kilometres, measured as number of seats multipled by kilometres flown. So we find units for revenue and cost. The basic breakdown is:

Revenue/ASK – Cost/ASK = Unit profitability

We can then compare the different airlines in the world to see which has the highest unit profitability. There is so much to tell that it is virtually impossible to voice out all my knowledge into a single blog post. Basically when you buy your ticket, you are giving the airline its main source of revenue. The airline also has admin costs, staff costs, handling charges that it has to continually expend to run the airline. As it flies from one airport to another, it also pays the airport charges levied against it. It also has to buy jet fuel from a supplier at whichever airport it lands.

Talking about fuel, as an analyst, we need to know where does the fuel come from that goes into the airline because fuel makes up about 50% of the airline’s cost. So it is worthwhile studying fuel cost. Basically, fuel comes from crude oil which is then refined to jet fuel. The cost of jet fuel is the main fuel cost of the airline. But it is expensive, and airlines are susceptible to rises in fuel costs, so what management can do is to engage in two types of defences. The first is fuel hedging, and the second is fuel surcharging. Fuel hedging involves buying options to buy/sell fuel at a certain price at or before a certain date so as to hedge fuel price movements. Fuel surcharging is passing on a portion of the increase in fuel charge to the customer so that the customer bears a bit of the cost. The equation is:

Crude Oil + refining margin = Unhedged jet fuel price
Unhedged fuel price – Hedging gains – Fuel Surcharge = Effective fuel price
Looking at the airline industry, it is also important to note how much gearing the airline company has. Airplanes depreciate every year, and so they need to replace those airplanes one day with newer, more efficient ones. Expenditure on airplanes is their main capex. Basically if earnings from operations after tax does not cover capex, then financing needs to be arranged for the deficit. It could involve either taking on more debt or issuing more shares. Since airplanes are so expensive to acquire, and usually their capex is high, operating cash flow is not enough to cover capex. Hence airlines usually would have high debt in their balance sheets. The successful airlines are able to maintain their core business and steal market share away from competitors and able to finance their capex using only operating cashflow. The fact that there is high capex also restricts dividend payments to shareholders.

After seeing many reports done in the industry about different airlines like Singapore airlines and Air asia, I would kind of know that airlines compete based on price of their fares. The successful airline would always be the airline that gets the most passengers and still makes money. In times of boom, the premium airlines do enjoy more passengers flocking to business class seats, but the low cost carriers also do enjoy a higher proportion of growth as poorer people suddenly have the income to fly. As there is more poor people than rich people, I conclude that the low cost carriers will benefit more in boom times. In recession times, the low cost carriers will actually be more resilient as demand first falls in business class seats, so the premium airlines will suffer a hit.

Looking already at the economics of the airline industry, and there is also many more ways in analysing an airline including looking at its passenger load factor growth, yield growth and cost growth, if I had to choose an airline anyway, I would certainly pick the one that has the highest growth potential, the lowest cost to run, a brand that people actually trust and would recommend their friends to go on, low or no borrowings in its balance sheet, has a good supply of aircrafts coming in and has already secured financing for them, a visionary management team, would have short-haul trips as their core business and long-haul trips as secondary(because the profitability is higher short-haul) and last but not least, makes at least 12% return on its equity invested in the business.